The International Accounting Standard Board (IASB or Board) issued the new Insurance Accounting Standard, IFRS 17 Insurance Contracts (the Standard) on May 18, 2017, with an original effective date from January 1, 2021 onwards. Just a few days ago, specifically on November 14, the IASB voted in favour of a proposal to defer the effective date for IFRS 17 to 2022. The deferral is subject to a public consultation which is expected to take place in 2019.
It represents the most significant change to European insurance accounting requirements in two decades, requiring insurers to entirely overhaul their financial statements. Given the scale of this change, investors and other stakeholders will want to understand the likely impact as early as possible.
The standard uses three measurement approaches.
The first is the general model or building block approach (BBA). This is the default valuation approach for the insurance contracts. The latter will be valued by calculating the present expected future cash flows plus a risk adjustment. Any day one gain is offset by the contractual service margin (CSM) which represents unearned profit the insurer recognises as it provides services under the contract. The CSM is unlocked for the impact of changes in fulfilment cash flows and risk adjustment relating to future coverage.
The second is the premium allocation approach (PAA). This is the optional simplified approach for contracts with a coverage period of one year or less or where it is a reasonable approximation to the BBA method. Many non-life and some life insurance contracts written by Maltese insurers are expected to meet these criteria. The valuation of insurance contracts will be similar to existing non-life insurance contract approaches with respect to pre-claims coverage liability (unearned premiums). On the other hand, the incurred claims liability is valued using the fulfilment of cash flows similar to the Solvency II best estimate claim reserving.
IFRS will impact processes, IT systems and reporting timetables
The third is the variable fee approach (VFA). This methodology will apply to contracts with direct participation features. The principles underlying these measurement approaches will result in a fundamental change to current practice, particularly for long duration contracts. The insurance contract liability is based on the obligation on the entity to pay the policyholder an amount equal to the value of the underlying items, net of a consideration charged for the contract (variable fee). Changes in financial assumptions will be offset against the CSM if they are related to future service.
To date, most European insurers have mostly performed a limited impact assessment for IFRS 17, with implementation projects mobilising in early 2018 to analyse and evaluate. Casting the focus on the Maltese insurance market, it is pertinent that insurers will now start focusing on the IFRS 17 project and leverage on the lessons learned from the bumpy yet successful implementation of the Solvency II regulatory regime.
Opinion surveys of European insurers who are beyond IFRS 17 project inception convey the common message that IFRS 17 represents a tougher challenge compared to Solvency II. IFRS 17 will not only impact the figures presented to stakeholders in financial statements but it will impact data, processes, IT systems and reporting timetables.
In the coming years, insurers will need to interpret and apply the requirements to their insurance contracts – a process involving significant time and effort. The major change programme required will extend beyond finance and actuarial teams and its impacts will need to be communicated to a broad range of internal and external stakeholders.
The requirements are markedly different to existing accounting practices in a number of critical aspects that will: change profit emergence patterns; increase the frequency of loss recognition; and add complexity to valuation processes, data requirements and assumption setting. Given the scale of the standard’s impact and the complexity of its implementation, local insurers should mobilise their organisations now and start to formally assess the impact through a gap assessment.
In addition, over the next four years insurers will need to adopt a raft of other accounting changes including IFRS 9 Financial Instruments (the IASB has also proposed a deferral of IFRS 9 for insurers to 2022) and more imminently IFRS 16 Leases.
Thus, insurers must be prepared to educate stakeholders on the expected impacts and communicate their execution plans. This will require a well-planned programme and a clear organisational view of the effects of the new standard.
A two-hour seminar titled Demystifying IFRS 17 – What does it mean for you? will take place at EY Connect Centre on November 28.
Shawn Falzon is partner, Insurance Assurance Leader. Frank Cassar is senior manager, Insurance Assurance.